The Obama Tax Plan

by Veronique de Rugy

Yesterday, I talked about Obama’s request for $50 billion in infrastructure spending. It’s a bad idea.

Today, I want to look at the tax side of the proposal. Under the president’s plan, businesses would be allowed to expense investment expenditures.  In other words, businesses would be able to immediately deduct 100 percent of the cost of new investment in plants and equipment, when calculating their taxable income, rather than having to gradually deduct the cost via depreciation allowances. The direct consequence of the proposal is that companies would be able to keep more cash now.

The hope is that companies who may be hesitant to invest and are holding cash today will have an incentive to expand, which might help the economy recover. From BusinessWeek:

Companies combining deductions proposed by Obama for equipment with deductions for borrowing costs would get benefits — including refunds or credits against future taxes — that exceed the additional income they get from new capital spending, according to a 2005 report by the Congressional Budget Office. For every $1 of additional income from new capital spending, companies may be able to get benefits worth almost $1.88, according to the budget office report.

“The combination of free deductibility of interest to make a marginal investment, combined with accelerated depreciation, would lead to negative tax rates on that new investment,” [Ed] Kleinbard said.

This is what is bothersome about this proposal.  It’s a “tax subsidy for debt-financed investment.” Moreover, the government, once again, is playing with the tax code to encourage one form of behavior over another (spending/investing/borrowing over savings). I am not saying that savings is superior to investing or that any move from the current situation is a bad move. My point is just that the government shouldn’t be in the business of picking winners and losers. Encouraging investments and discouraging savings through artificial and temporary tax breaks is wrong. It is because of the many decisions that were made by businesses and individuals based on targeted government policies that we are in this mess in the first place (think about the decision to buy a bigger house than you would have otherwise because of the interest tax deduction or low interest rates).

Instead of playing with the tax code, the administration should engage in serious tax reform and move to a consumption-based tax with a large base and a low rate. Besides, how likely is it that this proposal will have any real impact? Not very likely, said Harvard University’s Greg Mankiw:

However, the impact will be relatively modest. Notice that expensing merely accelerates deductions. Thus, the value to the firm depends on interest rates. With interest rates near zero, the impetus to investment is small. Put another way, this policy can be seen as giving firms a zero-interest loan if they invest in equipment. But with interest rates near zero anyway, the value of the loan is not that great.